Tuesday, August 18, 2009

What Does the 20th Century Outperformance of Stocks over Government Bonds Presage?

Found on Naked Capitalism today:

The average return for U.S. stocks has trailed government bonds by about 8.6 percentage points annually since 1999, after outperforming by 8.2 points last century, based on data compiled by the London Business School and Zurich-based Credit Suisse Group AG.Sellers of stock will point to that statistic-- which ignores the transaction costs involved in trading stocks (remember that commissions were huge for most of the prior century) and say that it's time for stocks to resume their historic outperformance over Govvies.

I would say that one never knows, but perhaps a century from now, people will look back at the 1% 30-year government yields and chronic beneficial deflation due to massive productivity gains and look at stocks trading under tangible book value and say that Govvies are historically the way to go!

Today, brokers have a financial incentive to sell their customers almost anything except a long Government bond. Thus, only pros such as banks buy these bonds- and they rarely sell them. Thus, the current state of affairs in the pricing of Govvies has occurred without a sales effort to the public. The longer a near-zero interest-rate world continues on the short end, the more people will embrace yield. Just think if the investing public's investing tastes went from 1% allocation to Govvies, 13% CD's and demand deposits and 25% stocks to 5% Govvies and 2% less of each of the other categories named above. Couple that with cyclical improvement in the Federal deficit, and you could have the declining trend in the 10-year bond continue farther than almost anyone expects.